Generation-Skipping Trusts
Estate planning is the process of developing a series of documents that detail how a person’s assets should be distributed after his or her death. These assets collectively form the individual’s estate, whose distribution may be directed by a Last Will and Testament (will) and any combination of several types of trust. Generation-skipping trusts are one type of trust designed specifically to transfer wealth from one generation to another. Selecting the optimum type of trust and the most effective suite of estate planning documents can be a complex operation, dependent on the individual’s needs, wants, and circumstances. Therefore, consulting with an experienced estate planning attorney prior to initiating the process may be beneficial. Residents of Arizona can call (480) 320-2310 to schedule an informative consultation with an experienced estate planning attorney from Harrison Law, PLLC.
Understanding Generation-Skipping Trusts
The main purpose of an estate trust is to create a legal entity that shields an estate from prolonged probate, creditor claims, and certain taxes. As may be inferred from their name, generation-skipping trusts typically transfer the assets of an estate to the grantor’s grandchildren. The grantor, also known as the settlor or trustor, deliberately bypasses his or her offspring to bequeath the inheritance directly to the next generation, which can include individuals not biologically related to the grantor provided these beneficiaries are younger than the grantor by at least 37.5 years.
Like other trusts, generation-skipping trusts are legally binding fiduciary agreements approved by the courts. Trusts are broadly classified as revocable or irrevocable, depending on whether the grantor can “take back” the trust during his or her lifetime. Generation-skipping trusts fall into the irrevocable category. While irrevocable trusts lack flexibility for modification, they present enhanced tax benefits and asset protection. As a result, generation-skipping trusts often offer a strategy for preserving family wealth by sidestepping one round of estate taxes.
How Do Generation-Skipping Trusts Work?
According to the Internal Revenue Service (IRS), the beneficiary of a generation-skipping trust must be two or more generations younger than the trustor. However, the scope of generation-skipping trusts extends beyond grandchildren to encompass anyone younger than the trustor by at least 37.5 years. That widens the spectrum of potential transferees to include nieces, great-nephews, or even children born later in the trustor’s life. Blood relation is not a prerequisite as long as the age threshold is met.
Considering Taxes
Traditional revocable trusts typically expose assets to estate taxes. The establishment of generation
-skipping trusts may offer a shield against some of the taxes that would normally be imposed on the inheritance when passing an estate to one’s children. Congress, however, has instituted a generation-skipping tax (GST) to counteract the exploitation of this loophole. According to the Arizona State Senate, Arizona has no estate tax, but federal estate taxes might apply. In some cases, the federal estate tax may be as high as 40% of the total gross value of the estate. With the current threshold for 2024 being $13.61 million, unless your estate has an extremely high value, it could be exempt from estate taxes.
Providing for the Skipped Generation
What happens to that skipped generation? Are the grantor’s children truly skipped? According to the IRS, the beneficiary of the generation-skipping trust must be two or more generations younger than the trustor. However, with a carefully built trust, the grantor’s children can receive earnings from the assets included in the trust to provide for them throughout their lifetimes. You may wish to discuss your unique needs with an estate planning attorney from Harrison Law, PLLC, to determine whether this type of trust will provide for your family members in the way you desire.
Benefits of Generation-Skipping Trusts
Generation-skipping trusts can be an attractive estate planning tool with many advantages for certain estates. Strategic planning and avoidance of estate taxes are among the most widely sought benefits.
Strategic Planning for Larger Estates
A generation-skipping trust can act as a mechanism to ensure the preservation of the family legacy for at least two generations. This means that generation-skipping trusts may be especially attractive to families seeking to build generational wealth.
Avoidance of Estate Taxes
In some cases, it may be possible to avoid a round of estate taxes by diverting assets away from direct inheritance to the grantor’s children. Estate taxes will still be assessed to the “skip person,” the beneficiary, but when passing an estate to children who then pass it to their children, the value of the total estate may essentially be taxed twice.
Disadvantages of Generation-Skipping Trusts
As with any type of trust, there are also disadvantages to consider when making estate planning decisions. The disadvantages of generation-skipping trusts can include the following:
Generation-Skipping Tax
Estates surpassing the $13.61 million exemption amount may be subject to both the generation-skipping tax and estate taxes. The GST is meant to prevent a family from avoiding taxes by skipping a generation. The resulting taxes due are meant to be similar to the taxes that would have been due if the estate had passed from one generation to the next without skipping.
Administrative Burden
The management of trusts demands thoughtful attention, energy, and resources. Identifying a dedicated trustee to assume the fiduciary responsibilities involved is essential to ensuring that generation-skipping trusts realize their potential to maximize and perpetuate a family’s legacy.
Irrevocable Nature of Generation-Skipping Trusts
Generation-skipping trusts fall into the category of irrevocable trusts. Despite the name, an irrevocable trust may sometimes be dissolved. If all the beneficiaries agree, the purpose of the trust has been fulfilled or is no longer possible, or a court issues an order to terminate, the trust can legally dissolve. Upon termination, the assets included in the trust will be distributed to the beneficiaries according to either the trust document or a court order. At that time, the beneficiaries may be responsible for certain taxes.
Ask an Estate Planning Attorney About Generation-Skipping Trusts Today
Generation-skipping trusts serve as a strategic means to prevent double taxation in the transfer of generational wealth for many estates. Double taxes can occur when the same assets pass to children and then later to grandchildren. Due to the legal complexities involved, if you are thinking about establishing a generation-skipping trust, consider consulting with an experienced estate planning attorney from Harrison Law, PLLC. To get insight into how these and other trusts operate, call (480) 320-2310 to set up your personalized consultation today.
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This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
